November 28 2007
On October 31 2007 the finance minister informed Parliament of the outcome of an investigation into private equity and hedge funds that aimed to identify potential problems and create a clear strategy for such investments. The investigation was conducted by an RSM Erasmus University Rotterdam research team and included relevant scientific studies and actual cases. An inquiry was also conducted into listed companies.
The investigation team concluded that recent events which have caused concern are not representative of the entire private equity and hedge fund sector. Private equity investments with the sole purpose of making profit quickly without adding value to the target company are rare. Further, hedge funds engaged in real shareholder activity form a relatively small part of the sector. On average, the effects of private equity and hedge funds on the economy and businesses have been positive.
It was assumed that private equity investors solely buy out the stock exchange, thereby creating negative effects for target companies. However, this does not seem to be the reality. Most takeovers are still carried out by non-financial parties within the industry itself. Private equity takeovers are generally friendly takeovers, enacted with the consent or on request of the target company. The effects on the profitability, productivity and innovation of the targets have been mainly positive. Any perception that most acquired companies are resold shortly after acquisition has arisen from unusual cases. The investigation was apparently initiated on the basis of certain contentious incidents. However, with the private equity sector growing, stiff competition is expected between investors and competition between financing banks should also increase a result. This, together with higher takeover premiums arising as a result of the increased competition between private equity investors, may lead banks to ease their credit facilities and restrictions. This could create payment problems that affect target companies and their shareholders. The Dutch Central Bank has therefore issued a policy rule for risk management in respect of alternative investments. However, since the largest commercial banks are non-Dutch, the Ministry of Finance advises an international approach in order to strengthen the indirect supervision of private equity investments.
Most concerns over hedge funds related to shareholder activity. However, not all active shareholders are hedge funds. Two percent to 5% of hedge funds act as active shareholders and the policies of such hedge funds are fairly diverse. The perception that shareholder activity is always detrimental to target companies was not supported by the investigation’s findings. Generally, hedge fund actions lead to a slight increase in operational results because company management is kept alert. The investigation concluded that there is no comprehensive definition of ‘hedge funds’ and that hedge fund strategies are not limited to use by hedge funds themselves. Most hedge funds are established offshore (eg, Cayman), and are therefore unaffected by Dutch and/or EU legislation. Such strategies are effective when taking action regarding:
Those specific strategies are:
The Ministry of Finance believes that hedge fund supervision must be enhanced through hedge fund equity and through credit providers which are already subject to supervision. This would involve: (i) enhancing risk management; and (ii) procuring party insistence on strong credit conditions and transparency. This will create market discipline, which has a positive effect on hedge funds. The Ministry of Finance announced that it is committed to an international approach in order to discourage empty voting through securities lending, and that it will urge the European Commission to prioritize this. The European Commission will be requested to elaborate on options for greater transparency regarding securities lending and any possible influence on lenders (mostly professional investors). This could be done through a code of conduct which, for example, contains provisions in respect of the return of securities that are lent prior to an important meeting of shareholders.
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